Opinion: Buying oil stocks at these prices is just spilling money

About a month ago, some traders were trumpeting that the worst was over for oil. Prices normalized around $60 after a snap-back in spring, with energy seemingly on solid footing once more as we neared the end of the second quarter.

In July, though, all bets were off as crude tumbled sharply to near six-month lows, shedding about 20% in a matter of weeks. That once again puts oil prices within spitting distance of their 2009 lows.

It may be tempting to think you can find a bargain in oil stocks on this pullback, or even that you can play the supposed rebound in crude via commodity futures or related exchange-traded products.

But the pain in oil is far from over, and energy stocks are no bargain.

Here’s why:

1. The U.S. is a major oil producer: Supply gluts persist despite the recent cutbacks in domestic oil production. Consider that, according to the U.S. Energy Information Administration, U.S. crude oil production will average 9.5 million barrels a day in 2015 — up significantly from 8.7 million in 2014. And while cutbacks will drop that output to 9.3 million barrels daily in 2016, according to EIA projections, that’s still well above 2014 levels.

2. Oil is abundant worldwide: OPEC has refused to curtail production despite low prices and increased supplies from the U.S. That’s partially because of nations including Saudi Arabia that want to punish U.S. shale oil companies, which are now competitors in a big way on the global stage, but also because OPEC really has no other options but to keep pumping.

Member states of the cartel need revenue to fund their governments, so cheap oil paradoxically requires nations to sell more in such an environment to make budgets work. Furthermore, a serious change in production would validate fears that the global energy markets are no longer in their control — an idea that Middle East plutocrats cannot allow their citizenry to entertain. That all adds up to record global crude inventories in May (the latest data) that covered roughly 31 days of forward demand — even if another drop of oil isn’t taken out of the ground.

3. Iran has oil to sell: To make matters worse on the oil front, any easing of sanctions with Iran will undoubtedly make the situation even worse. Say what you want about the Obama administration’s overtures toward normalization with Iran, but the bottom line is that if the deal goes through, we are going to see even more of a supply glut after this Middle Eastern energy giant is allowed to sell its oil on global markets.

4. Demand is flat: Oil demand is falling even as supplies remain robust. The International Energy Agency projects that global oil demand growth peaked in the first-quarter of this year (in part thanks to super-cheap prices) and will slow across this year and into 2016. And while oil demand is admittedly rising modestly, a focus on efficiencies around the world has kept a cap on energy appetites — so much so that the gap between oil production and demand has continued to grow steadily across this year. That double-whammy of robust supply and weak demand is not something crude oil will easily overcome anytime soon.

5. Strong dollar headwinds: The icing on the cake is a strong U.S. currency that is hovering around 12-year highs vs. other currencies thanks to loose monetary policy in Japan, debt troubles in Europe, and general mayhem in China and Russia. And there continues to be a drumbeat for tighter Federal Reserve policies in the near future, which will only solidify the power of the dollar
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even more. A strong dollar acts as a cap on commodity prices, so even if supply and demand both right themselves — an incredibly tall order — they will have to overcome foreign exchange challenges to boot.

6. Big oil is battered: You may find some vulture investors buying shares of Exxon Mobil
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or Chevron
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here, and I’ll admit that neither Big Oil stalwart is going to zero anytime soon. However, Exxon and Chevron are both trading at forward price-to-earnings ratios of almost 16 — hardly once-in-a-lifetime bargains for either pick. And yes, the dividends may soften the blow, but don’t expect the payouts to grow much as earnings remain challenged. When a mega-cap oil stock like Exoxon suffers a steady 20% drop across 12 months despite a dominant business and a triple-A credit rating, it’s hard to state with confidence that the worst is over in this environment. Many investors have been burned and won’t be eager to throw their cash after oil stocks anytime soon.

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